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Soon The Economic Deluge


Daniel Oliver Jr.

With the dollar in freefall, the monetary system is breaking down

The international monetary system set up at Bretton Woods in 1944 is on the verge of breaking down. It could still be saved by heroic measures, especially if these were taken in the United States. They would include an immediate slash in projected government expenditures, an immediate balancing of the budget, and a halt in any further increase in the stock of money.

But in the present political and ideological atmosphere, these measures are very unlikely.

Parallel measures are even more unlikely in Britain or in France. The government in Britain will never give up its socialistic obsessions. In France, Nicolas Sarkozy is caught in a chronic dilemma of either yielding to untenable wage demands or having his country paralyzed by strikes.

And nearly every other country, in varying degree, now operates on the fixed assumption that at least some inflation, some constant increase in its stock of paper money, is necessary to prevent an economic slowdown or setback.

The four paragraphs above–substituting “Charles de Gaulle” for “Sarkozy” and adding “Labor” before “government in Britain”–appeared at the beginning of a Los Angeles Times editorial written by Henry Hazlitt in March of 1969. The editorial concluded that the U.S. was certain to leave the gold standard and commence an inflationary devaluation, with resulting economic chaos.

Two years later, President Nixon appeared on national television to “suspend temporarily the convertibility of the dollar into gold.” The second part of Hazlitt’s prediction took longer to manifest itself. In fact, the inflation rate as measured by the Consumer Price Index sank from 5.2% when Hazlitt wrote the editorial to 2.7% in 1972. Initially it seemed Nixon was correct that suspending convertibility would paradoxically “protect the position of the American dollar.” A speculator betting on inflation 1969 would have gone broke.

But what Hazlitt knew, and Nixon didn’t, is that inflation has great momentum. The price level can withstand significant monetary abuse, but once inflationary expectations cement they are impossible to dislodge without extreme economic and political pain, as Ford, Carter, and Reagan soon discovered.

The similarities between then and now are obvious. Despite the Republican takeover in the House, there is no chance of restraint at the Fed or a balanced budget. The tax deal passed in the lame-duck session will add nearly $1 trillion in deficits, most of which the Fed will be forced to monetize.

Although the Conservatives have gained power in Britain, their “austerity” plan is to return spending back to 2007 levels–in terms of projected GDP. Nominal spending is set to increase. Meanwhile, France continues to have strikes, as do Britain, Ireland, Italy and Greece.

The inflation rate has fallen for the past three years, as it did between 1969 and 1972, but monetary policy has caused commodity prices to surge back to 2008 bubble highs despite rising unemployment. Anecdotal evidence of pricing turmoil for foreign producers of intermediate goods suggests that inflation is already lurking just offshore, preparing to crash into the economy. The higher costs will cause commerce to freeze, as it did in 2008, or else the inflation spiral will again begin in earnest. Either way, European-style protests will soon come to these shores as well.

This is not the mainstream view, just as Hazlitt’s view was not shared by mainstream economists. Only two months after he wrote the lines above Time Magazine ran an article titled “The Future: The Sizzling 70s,” which cited a study by two dozen economists at the National Industrial Conference Board that predicted a 40% increase in the real standard of living over the subsequent decade. Instead, by 1981 real median income had decreased by over 6%.

Hazlitt got it right because he understood free-market economics and had studied the wreckage of numerous historical inflationary experiments. Only those with his perspective knew how to protect their wealth against the inevitable consequences of bad monetary policy. It will be the same now.

From 1969 to 1980 the dollar lost 96% of its value in terms of gold and 92% in terms of oil. The stock market was no safe haven: The Dow’s nominal value in 1980 was the same as in 1969, meaning it lost similar value against gold and oil.

In the current cycle, the dollar and the Dow began deflating in 1999. With gold at $1,400 and oil at $90, the dollar and the Dow have declined by nearly 80% against both. To match the 1970s, they would have to lose another 80% against gold and another 60% against oil, implying gold at $7,000 and oil over $200. Given that the current monetary abuse is far worse than in the 1960s and 1970s, these figures are conservative.

Bretton Woods II is collapsing. The seductive Keynesian policies that fiscal and monetary authorities have followed for decades will soon cause the end of dollar hegemony. The United States is entering its third consecutive year of deficits greater than $1 trillion coupled with continuing dramatic increases in the stock of money. Devaluation and economic chaos are guaranteed, just as they were in 1969. Fortunately, unlike in 1969, gold ownership is legal. Those who understand free markets can still preserve the capital that will be needed to restore American prosperity after the deluge.

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